Patrick Jake O’Rourke an American political satirist and journalist recounts a very interesting story in his book Age and Guile – Beat Youth, Innocence and a Bad Haircut.
It was 1969 and O’Rourke had applied for a fellowship. To get the fellowship he had to clear an interview at the Ohio State University English Department.
On reaching there he was asked “Which literary critic has had the most profound influence on your thinking?”
“I could not think of the name of a single literary critic,” recalls O’Rourke in the book. But of course he had to say something, which he did.
“Henry David Thoreau,” was his answer to the question. Thoreau was an American poet, author and philosopher.
“Henry David Thoreau wasn’t a literary critic,” the board interviewing him rightly pointed out.
“His whole life was an act of literary criticism,” retorted O’Rourke.
He got the scholarship. “Well, it was 1969. Bullshit was an intellectual mainstay of the era,” he writes.
Bullshitting or BS as it is more euphemistically referred to as is a very important part of life in general and corporate life in particular. If one needs to survive and get out of tricky situations, learning how to give bullshit as well as decipher it is, very important.
Take the case of the decision made by the Life Insurance Corporation of India to relaunch Unit Linked Insurance Plans (Ulips) after a gap of nearly two years. Ulips are essentially high cost mutual funds masquerading as insurance. A major part of the premium collected through selling Ulips is invested in the stock market.
As the Business Standard reports today “The intention is to take advantage of the bullishness in the stock market. Sources familiar with the developments said this would also help the insurer attain its target of Rs 45,000 crore of new premium income collection in 2012-13 and increase its market share.”
Now this is what one would call bullshitting. Giving out every reason for a decision except the real one. And what is the real reason for LIC suddenly deciding to launch Ulips?
The real reason for LIC suddenly deciding to launch Ulips is the disinvestment programme of the government. At the beginning of the year the government had targeted to raise Rs 30,000 crore by selling shares of public sector enterprises to investors.
But now that number will have to go up due to several reasons. The government has been spending money at a faster rate than it had envisaged. The fiscal deficit during the first six months of the year had already reached 65% of the targeted amount of Rs 5,13,590 crore.
The tax collections have slowed down and only 40% of the projected amount has been collected during the first six months of the year.
Also, the auction of telecom spectrum through which the government had plans of raising Rs 40,000 crore has turned out to be a damp squib. The government could collect only Rs 1,707 crore or around 4.3% of the targeted amount.
This means a short fall of nearly Rs 38,300 crore which will now have to be most probably made up through the disinvestment route. Hence, a total of around at least Rs 68,000 crore (Rs 38,300 crore + the earlier target of Rs 30,000 crore) will now have to be raised through disinvestment.
This means the government will have to sell shares of a lot of public sector companies to investors. But the question is whether investors have an appetite for it?
And the answer is no given the current mess that the government is in. This is where LIC comes in. India’s biggest insurer bought a major part of the recent sale of shares of Hindustan Copper Ltd by the government and thus rescued its disinvestment.
And this is something that LIC is expected to do over and over again till March 31, 2012 and help the government meet its disinvestment target. Recently the government allowed LIC to own up to 30% of a company against the earlier stipulated limit of 10%.
Hence, LIC will end up buying shares which the government wants it to buy rather than the shares it should be buying from the point of view of generating good returns for its investors. Given this, LIC needs money which has the mandate to be invested in equity. The premium that it collects through its traditional endowment plans needs to be invested in safer avenues like government securities and loans raised by the best companies.
This money cannot be invested in the stock market. The money raised through selling Ulips can be invested in stocks. And that is the kind of money that LIC needs right now. Thus the decision to launch Ulips after a two year hiatus.
Also the last three months of the financial year are the best time to sell Ulips or any other kind of insurance plan, given that this is the time most people get around to doing their tax planning and investing money in tax saving avenues, insurance is one of which.
Ulips were the wonder drug for the insurance industry for a very long period of time until investors started figuring out that the only person gaining from the Ulip was the insurance agent. Also, the clamp down by Insurance Regulatory and Development Authority (IRDA) of India, the insurance regulator, on Ulip commissions, pushed insurance agents towards traditional insurance plans which continue to pay a high commission.
Now Ulips are all set to act as the wonder drug for the government. The money raised by LIC by selling its new Ulips is likely to be invested in the shares of the public sector units the government plans to sell to meet its disinvestment target.
It’s a win a win proposition for everyone. The government gets its easy money. LIC gets new premium on which it charges a management fee to manage that money. The insurance agent makes the commission. The only person losing out, as always, is the person buying the Ulip, who ends up indirectly owning shares that no one else in the market wants to buy. But then who was bothered about him anyway? He could always be bullshitted and told it was all for his own good.
Today’sEconomic Times says that the LIC lost over Rs 5,000 crore by buying public sector shares of ONGC, NMDC and NTPC.
But DK Mehrotra, chairman, LIC had told Business Standard on an earlier occasion “Ulip has its own advantages, it gives you fast returns.” But the question Mehrotra does not answer is faster returns for whom? It clearly isn’t the Ulip investor.
Hence, dear reader it is important that you decipher this bullshit and allocate your hard earned money somewhere else.
The article originally appeared on www.firstpost.com on December 4, 2012.
(Vivek Kaul is a writer. He can be reached at [email protected])
“We’re slowly learning that fact. And we’re very, very pissed off.”
—Lines from the movie Fight Club
The government’s piggybank is in trouble. Well not major trouble. But yes some trouble.
The global credit rating agency Moody’s on Monday downgraded the Life Insurance Corporation (LIC) of India from a Baa2 rating to Baa3 rating. This is the lowest investment grade rating given by Moody’s. The top 10 ratings given by Moody’s fall in the investment grade category.
Moody’s has downgraded LIC due to three reasons: a) for picking up stake in the divestment of stocks like ONGC, when no one else was willing, to help the government reduce its fiscal deficit. b) for picking up stakes in a lot of public sector banks. c) having excessive exposure to bonds issued by the government of India to finance its fiscal deficit.
While the downgrade will have no impact on the way India’s largest insurer operates within India, it does raise a few basic issues which need to be discussed threadbare.
From Africa with Love
The wives of certain African dictators before going on a shopping trip to Europe used to visit the central bank of their country in order to stuff their wallets with dollars. The African dictators and their extended families used the money lying with the central banks of their countries as their personal piggybank. Whenever they required money they used to simply dip into the reserves at the central bank.
While the government of India has not fallen to a similar level there is no doubt that it treats LIC like a piggybank, rushing to it whenever it needs the money.
So why does the government use LIC as its piggybank? The answer is very simple. It spends more than what it earns. The difference between what the government earns and what it spends is referred to as the fiscal deficit.
In the year 2007-2008 (i.e. between April 1, 2007 and March 31,2008) the fiscal deficit of the government of India stood at Rs 1,26,912 crore. Fiscal deficit is the difference between what the government earns and what it spends. For the year 2011-2012 (i.e. between April 1, 2011 and March 31, 2012) the fiscal deficit is expected to be Rs 5,21,980 crore.
Hence the fiscal deficit has increased by a whopping 312% between 2007 and 2012. During the same period the income earned by the government has gone up by only 36% to Rs 7,96,740 crore. The expenses of the government have risen more than eight and half times faster than its revenues.
What is interesting is that the fiscal deficit numbers would have been much higher had the government not got LIC to buy shares of public sector companies it was selling to bring down the fiscal deficit.
Estimates made by the Business Standard Research Bureau in early March showed that LIC had invested around Rs 12,400 crore out of the total Rs 45,000 crore that the government had collected through the divestment of shares in seven public sector units since 2009. The value of these shares in March was around Rs 9,379 crore. Since early March the BSE Sensex has fallen 7.4%, which means that the LIC investment would have lost further value.
Over and above this the government also forced LIC to pick up 90% of the 5% follow-on offer from the ONGC in early March this year. This after the stock market did not show any interest in buying the shares of the oil major. The money raised through this divestment of shares went towards lowering the fiscal deficit of the government of India.
News reports also suggest that LIC was buying shares of ONGC in the months before the public issue of the insurance major hit the stock market, in an effort to bid up its price. Between December and March before the public offer, the government first got LIC to buy shares of ONGC and bid up the price of the stock from around Rs 260 in late December to Rs 293 by the end of February. After LIC had bid up the price of ONGC, the government then asked it to buy 90% of the shares on sale in the follow on public offer.
This is a unique investment philosophy where institutional investor managing money for the small retail investor, first bid up the price of the stock by buying small chunks of it, and then bought a large chunk at a higher price. Stock market gurus keep repeating the investment philosophy of “buy low-sell high” to make money in the stock market. The government likes LIC to follow precisely the opposite investment philosophy of “buying high”.
Estimates made by Business Standard suggest that LIC in total bought ONGC shares worth Rs 15,000 crore. The stock is since down more than 10%.
The bank bang
LIC again came to the rescue of the cash starved government during the first three months of this year, when it was force to buy shares of several government owned banks which needed more capital. It is now sitting on losses from these investments.
Take the case of Viajya Bank. It issued shares to LIC at a price of Rs 64.27 per share. Since then the price of the stock has fallen nearly 19%.
The same is case with Dena Bank. The stock price is down by almost 10% since allocation of shares to LIC. The share price of Indian Overseas Bank is down by almost 19.7% since it sold shares to LIC to boost its equity capital. While the broader stock market has also fallen during the period it hasn’t fallen as much as the stock prices of these shares have.
There are more than a few issues that crop up here. This special allotment of shares to LIC to raise capital has pushed up the ownership of LIC in many banks beyond the 10% mandated by the Insurance Regulatory and Development Authority of India, the insurance regulator. As any investment professional will tell you that having excessive exposure one particular company or sector isn’t a good strategy, especially when managing money for the retail investor, which is what LIC primarily does. What is interesting is that the government is breaking its own laws and thus not setting a great precedent for the private sector.
If LIC hadn’t picked up the shares of these banks, the fiscal deficit of the government would have gone up further. The third issue here is why should the government run so many banks? The government of India runs twenty six banks (20 public sector banks + State Bank of India and its five subsidiaries).
While given that banking is a sensitive sector and some government presence is required, but that doesn’t mean that the government has to run 26 banks. It is time to privatise some of these banks.
Gentlemen prefer bonds
As of December 31, 2011, the ratio of government securities to adjusted shareholders’ equity in LIC was 764%. This is understandable given that the subsidy heavy budget of the Congress led UPA government has seen its fiscal deficit balloon by 312% over the last five years. Again basic investment philosophy tells us that having a large exposure to one investment isn’t really a great idea, even if it’s a government.
The Rahul factor
But the most basic issue here is the fact that the government is using the small savings of the average Indian who buys LIC policies to make loss making investments. This is simply not done.
LIC has turned into the behemoth that it has over the years by offering high commissions to its agents over the years. It sells very little of “term insurance”, the real insurance. What it basically sells are investment policies with very high expenses which are used to pay high commissions to it’s the agents. The high commissions in turn ensure that these agents continue to hard-sell LIC’s extremely high cost investment policies to normal gullible Indians. The premium keeps coming in and the government keeps using LIC as a piggybank.
The high front-loading of commissions is allowed by The Insurance Act, 1938. The commission for the first can be a maximum of 40 per cent of the premium. In years two and three, the caps are 7.5 per cent, and 5 per cent thereafter. These are the maximum caps and serve as a ceiling rather than a floor.
The Committee on Investor Protection and Awareness led by D Swarup, the then Chairman of Pension Fund Regulatory and Development Authority, had proposed in September 2009 to do away with commissions across financial products. “All retail financial products should go no-load by April 2011,” the committee had proposed in its reports.
The National Pension Scheme(NPS) was already on a no commission structure. And so were mutual funds since August 1, 2009. But LIC and the other insurance companies were allowed to pay high commissions to their agents. “Because there are almost three million small agents who will have to adjust to a new way of earning money, it is suggested that immediately the upfront commissions embedded in the premium paid be cut to no more than 15 per cent of the premium. This should fall to 7 per cent in 2010 and become nil by April 2011,” the committee had further proposed.
Not surprisingly the government quietly buried this groundbreaking report.
While insurance commissions have come down on unit linked insurance plans, the traditional insurance policies in which LIC remains a market leader continue to pay high commissions to their agents. These traditional insurance policies typically invest in debt (read government bonds which are issued to finance the fiscal deficit).
This is primarily because the Congress led UPA government needs the premium collected by LIC to run LIC like a piggybank. The piggybank money can and is being used to run subsidies in the hope that the beneficiaries vote for Rahul Gandhi in 2014.
Is the objective of LIC to generate returns and ensure the safety of the hard earned money of crores of it’s investors? Or is it to let the UPA government run it like a piggybank in the hope that Rahul baba becomes the Prime Minister?
The country is waiting for an answer.
(This post originally appeared on Firstpost.com on May 15,2012. http://www.firstpost.com/politics/lic-money-is-it-for-investors-benefit-or-rahul-election-309545.html)
(Vivek Kaul is a writer and can be reached at [email protected])